"Near-term, however, the momentum is undeniably bearish," they added.
The ICE BofA-ML MOVE index , which tracks bond market volatility - a gauge of investor risk aversion - is heading for its biggest two-week rise since late November, as yields around the world have jumped. It's still about 30% below October's 32-month high, and it's still narrowly above its lowest in almost two years, but February is proving to be a tough month for fixed income. Inflation data from the United States to the euro zone and Britain, Canada and Japan shows price pressures are definitely cooling, which is bringing some relief to cash-strapped consumers.
But it's proving to be persistent in less flexible areas of the economy, such as wages and the service sector, which is forcing investors to accept that interest rates might be near their peak, but that peak is higher than previously thought and rate cuts will take longer to materialise. European Central Bank board member Isabel Schnabel said in an interview on Friday that financial investors may be underestimating the persistence of inflation in the euro zone. They might be underestimating it a little less than they were a couple of weeks ago, based on what the market is doing. On Friday, a market-based gauge of long-term inflation expectations in the euro zone hit its highest since May last year. The five-year five-year forward inflation swap, which essentially reflects where investors believe inflation will be in 10 years' time , shot above 2.4%, from closer to 2.3% a week ago. Money markets show that for the euro zone, traders expect the ECB to keep raising rates to around 3.75% by November this year. That's an extra 50-bps in tightening that has been priced into the market in the last two weeks alone. FORGET 2023 RATE CUTS Schnabel's fellow board member, Fabio Panetta, who strategists at ING describe as an "arch dove" said on Thursday smaller rate hikes wouldn't necessarily mean a lower terminal rate, which greased the wheels of Thursday's fixed income sell-off. "What we witnessed yesterday to a greater degree again was the market pricing out the subsequent easing. From (now a higher) peak in 2023 through the end of 2024, that has been whittled down towards 80 bps from around 100 bps prior to the ECB meeting," ING's Antoine Bouvet said. Peripheral euro zone debt has been hit hard as a result. Italian two-year yields have risen by over a quarter of a percentage point this week alone.
Italian two-year yields nudged toward their highest since summer 2012, when the euro zone was mired in a multi-year debt crisis that forced bailouts for Greece, Portugal Ireland, as well as extensive support for the banking sector in countries like Spain and Cyprus. Two-year BTPs were last up 13 bps at 3.554%, having risen from below 3% at the start of the month, while 10-year yields rose 14 bps to 4.476%. ($1 = 0.9390 euros) (Reporting by Amanda Cooper; Editing by Hugh Lawson)
